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CH
AP
TE
R
I
S u p e r v i S i o n o f t h e b a n k i n g S e c t o r
1. Developments in the banking sector in 2008
2. Prudential supervisory practice
10
SuperviSion of the banking Sector
1. DevelopmentS in the banking Sector in 2008
1.1. Major events in 2008
1.1.1. A difficult year
The year 2008 will be remembered as annus horribilis in the financial sector. The collapse of Lehman
Brothers on 15 September 2008 marks the end of the “ancient world” in international finance,
whereas the outline of the “new world”, which will rise from the ashes of the “ancient world”, only
appears slowly.
The completely unforeseeable and unexpected change of paradigm which followed the bankruptcy
of Lehman Brothers swept deep-rooted certainties and entrenched ideas away. The sudden
disappearance of the interbank market and the drops in the financial assets weakened many
European banks. Almost all European states, or at least the ones which had the means, had to
greatly support their banking systems.
In Luxembourg, the subsidiaries of the three Icelandic banks Kaupthing, Landsbanki and Glitnir
were placed under the regime of suspension of payments following the failure of the parent
companies.
The Luxembourg government had to participate in the stabilisation action for Dexia and Fortis
groups, due to their systemic importance for the financial system.
1.1.2. Suspension of payments of Icelandic banks
Considering the crisis in the financial markets, the Icelandic parliament adopted a special law on 6
October 2008 conferring to the Icelandic supervisory authority special powers over the banks with
difficulties, including among others the power to exercise the prerogatives of the general meeting
of shareholders, to suspend the board of directors and to appoint a liquidation committee.
These powers were exercised on 7 October 2008 for Landsbanki Islands hf and Glitnir bank hf, and
on 9 October 2008 for Kaupthing bank hf, thus placing these banks under the regime of suspension
of payments.
Given that the liquidity reserves of the Luxembourg subsidiaries were kept at the respective
parent companies, the failure of the latter generated the immediate shortage of liquidity of the
Luxembourg subsidiaries as well as the suspension of payments.
• Landsbanki Luxembourg S.A.
On 8 October 2008 Landsbanki Luxembourg S.A. applied for the suspension of payments following
the freezing of liquid assets due to the failure of the parent company. The public limited company
Deloitte S.A., represented by Mr Franz Prost, was appointed administrator with the main mission of
setting up a recovery plan.
In his report of 25 November 2008, quoted in the judgment ordering the judicial winding-up, the
administrator concluded that due to the parent company’s reluctance to fulfil its commitment to
convert the debt into capital and to the refusal of BCL to subordinate its claims, together with an
increase in debt towards BCL due to the decrease in value and the technique of realisation of the
pledge used by BCL, a recovery of the bank seems unconceivable and the current assets will not, in
his opinion, satisfy the clients. Following this report, the State Prosecutor applied for an order for the
dissolution and the winding-up of Landsbanki Luxembourg S.A., judgment which was declared on
12 December 2008. Me Yvette Hamilius, attorney-at-law, and Mr Franz Prost, accountant, external
auditor and partner at Deloitte S.A., have been appointed liquidators.
11
chapter i
• Glitnir Bank Luxembourg S.A.
On 8 October 2008 Glitnir Bank Luxembourg S.A. applied for the suspension of payments considering
that the freezing of liquid assets due to the failure of the parent company did not allow the former
to fulfil the margin call set by the Luxembourg Central Bank. The company KPMG Advisory S.à r.l.,
represented by Mr Eric Collard, was appointed administrator with the main mission of setting up a
recovery plan.
The recovery of the bank not being possible, the administrator suggested the creditors a plan which
provides a voluntary winding-up after the immediate and full repayment of the depositors. This
plan was accepted by the creditors on 16 March 2009.
• Kaupthing Bank Luxembourg S.A.
The media events in Iceland led to the beginning of massive withdrawals of deposits from Kaupthing
Bank Luxembourg S.A.. At the same time, the parent company Kaupthing bank hf was placed
under the regime of suspension of payments on 9 October 2008. The liquidity problems arisen from
these events led Kaupthing Bank Luxembourg S.A. to apply for the suspension of payments on
9 October 2008. The company PricewaterhouseCoopers S.à r.l, represented by Mrs Emmanuelle
Caruel-Henniaux and Me Franz Fayot were appointed administrators with the main mission of
setting up a recovery plan.
At the date of the drawing-up of this report, a final recovery plan has not yet been put in place so
that the future of the bank is still uncertain.
• Intervention of the deposit guarantee scheme
At the time when the deposits of the three banks of Icelandic origin were unavailable, the AGDL
deposit guarantee scheme ensured the repayment of the deposits up to EUR 20,000. The total
amount to be distributed by the AGDL for the three banks is estimated approximately at EUR 320
million. The final loss for the AGDL cannot be determined until the end of the winding-up and
of the measures provided for in the recovery plans. The guarantee scheme was able to cover the
claims, considering that the banks set up provisions, which approximately amounted to EUR 800
million as at 31 December 2007, in order to cover such events.
1.2. Characteristics of the Luxembourg banking sector
The Luxembourg banking legislation provides for three types of banking licences, namely licences
governing the activities of universal banks (147 institutions had this status on 31 December 2008),
those governing the activities of banks issuing mortgage bonds (5 institutions had this status on 31
December 2008) and those governing the activities of banks issuing electronic means of payment
(no institution had this status on 31 December 2008).
The banks fall under three categories according to their legal status and geographical origin:
- banks incorporated under Luxembourg law (111 on 31 December 2008);
- branches of banks originating from an EU Member State or assimilated (33 on 31 December
2008);
- branches of banks originating from non-EU Member States (8 on 31 December 2008).
In addition, there is the special case of the unit formed by all caisses rurales (13 on 31 December
2008) and their central establishment, Banque Raiffeisen, which, according to the law on the
financial sector, is to be considered as a single credit institution.
12
SuperviSion of the banking Sector
1.3. Development in the number of credit institutions
With 152 entities authorised at the end of the financial year 2008, the number of banks decreased
by 4 entities as compared to 31 December 2007 (156). Among those 152 entities, 111 are banks
incorporated under Luxembourg law (113 in 2007) and 41 are branches (43 in 2007).
Development in the number of banks established in Luxembourg
Year Branches Subsidiaries Total
1988 24 119 1431989 27 139 166
1990 31 146 177
1991 36 151 1871992 62 151 213
1993 66 152 218
1994 70 152 222
1995 70 150 220
1996 70 151 221
1997 70 145 215
1998 69 140 209
1999 69 141 210
2000 63 139 202
2001 61 128 189
2002 55 122 177
2003 50 119 169
2004 46 116 162
2005 43 112 155
2006 42 114 156
2007 43 113 156
2008 41 111 152
Five banks were thus withdrawn from the official list during the year:
• Crédit Agricole Luxembourg Bank Merger with Crédit Agricole Luxembourg on 26 April 2008
• Banca Antonveneta S.p.A., succursale de Luxembourg
Cessation of activities on 30 June 2008
• Capitalia Luxembourg S.A. Merger with UniCredit International Bank (Luxembourg) S.A. on 1 July 2008
• Landsbanki Luxembourg S.A. Dissolution and judicial winding-up ordered on 12 December 2008
• Banque CIC Est, succursale de Luxembourg Cessation of activities on 31 December 2008
One bank started activities in 2008 :
• Banque Öhman S.A. 23 September 2008
Following its authorisation as bank, received on 6 December 2007, Banque Öhman S.A. finally
adopted this status on 23 September 2008. Banque Öhman S.A. belongs to the Swedish group
E. Öhman J: or AB and results from the change of the professional of the financial sector (PFS)
E. Öhman J: or Luxembourg S.A., authorised in Luxembourg since 9 March 2006, into a bank. The
group intends to offer loans to its current and future clients in the scope of its private banking
activity, and intends, at the same time, to supplement the range of the services offered by depositary
bank services.
SubsidiariesBranches
0
50
100
150
200
250
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
13
chapter i
The following credit institutions changed their name in 2008:
Former corporate name New corporate name (date of change)
Kredietbank S.A. Luxembourgeoise KBL European Private Bankers S.A. (19.03.2008)
Banco Popolare di Verona e Novara (Luxembourg) S.A.
Banco Popolare Luxembourg S.A. (27.02.2008)
Banque du Gothard (Luxembourg) S.A. BSI Luxembourg S.A. (01.07.2008)
Banque du Gothard S.A., succursale de Luxembourg
BSI Niederlassung Luxemburg (01.07.2008)
The Bank of New York Europe Limited, Luxembourg Branch
The Bank of New York Mellon (International) Ltd, Luxembourg Branch (01.07.2008)
PFPC Bank Limited, Luxembourg Branch PNC International Bank Limited, Luxembourg Branch (09.07.2008)
LRI Landesbank Rheinland-Pfalz International S.A.
LBBW Luxemburg S.A. (01.09.2008)
EFG Private Bank (Luxembourg) S.A. Eurobank EFG Private Bank Luxembourg S.A. (01.10.2008)
FORTIS BANQUE LUXEMBOURG BGL (22.12.2008)
The breakdown of credit institutions according to their geographical origin has changed as follows
(2007 figures between brackets). Banks of German origin remain the highest in number with 43 (43)
entities, followed by Belgian and Luxembourg banks with 21 (21) entities.
Geographical origin of banks
Country Number
Germany 43
Belgium / Luxembourg 21
France 14
Switzerland 12
Italy 11
Sweden 7
United Kingdom 6
United States 5
Japan 5
China 4
Netherlands 4
Brazil 3
Israel 3
Portugal 3
Denmark 2
Iceland 2
Others 7
Total 152
14
SuperviSion of the banking Sector
1.4. Development in the local branches network in Luxembourg
Following years of consolidation of the local branches network on the national territory, this trend
stopped in 2008.
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Local branches
240 231 226 225 214 207 200 253* 246* 234* 229* 229*
Banks concerned
11 11 10 9 9 8 8 9 9 9 9 9
* including the Caisses Rurales Raiffeisen affiliated to Banque Raiffeisen and the local branches of these Caisses Rurales.
1.5. Development in banking employment
The total number of employees of credit institutions of the financial centre as at 31 December 2008
reached 27,205, which represents an increase of 1,066 employees (+4.1%) over a year. Compared to
the 5.6% increase in 2007 or 6.5% in 2006, a certain slowdown in the growth is recorded; however,
it should be pointed out that the banking employment has increased for the fifth consecutive
year.
The view is less optimistic when we examine the quarterly development of this key figure of the
banking sector. Indeed, this view shows that the financial crisis, which sharply intensified during the
fourth quarter, is perfectly reflected in the level of employment created in the banking sector. While
employment increased by 374 units during the first quarter of 2008 and by 489 units in the second
quarter, this rhythm substantially calmed down between July and September 2008 with an increase
of only 267 units and at the end of the year a fall of 64 units was recorded.
Among the credit institutions registered on the official list as at 31 December 2008, 76.3%
maintained, or even increased, their staff over a period of one year. This percentage was 75%
in 2007, 74% in 2006 and 63% in 2005. During 2008, a total of 1,747 employments were created
whereas 681 disappeared following the cessation of activities by banks (cf. point 1.3. above) or
the direct or indirect impact (via the parent company) of the crisis. The banks that substantially
increased their staff are mainly those active in the investment funds sector and those that are
developing their presence in Luxembourg.
The breakdown of total employment shows that the share of executives within total employment
continued to grow. It rose from 23.5% to 24.9% during 2008. The female employment rate remained
almost unchanged with 45.7% (45.6% in 2007).
Breakdown of the number of employees per bank
Number of banks
Number of employees 2003 2004 2005 2006 2007 2008
> 1,000 4 4 4 5 5 5
500 to 1,000 4 2 6 7 9 8
400 to 500 4 6 4 3 2 4
300 to 400 6 8 7 8 10 11
200 to 300 11 8 7 10 9 8
100 to 200 19 19 20 18 18 16
50 to 100 21 21 18 18 21 20
< 50 100 94 89 87 82 80
Total 169 162 155 156 156 152
15
chapter i
Situ
atio
n o
f em
plo
ymen
t in
cre
dit
inst
itu
tio
ns
Tota
lM
anag
emen
tO
ffic
e st
aff
Tech
nic
al s
taff
Tota
l sta
ff
Lu
xem
b.
Fore
ign
ers
Men
Wo
men
Tota
lM
enW
om
enTo
tal
Men
Wo
men
Tota
lM
enW
om
enTo
tal
1995
8,17
0 10
,113
2,
533
451
2,98
4 7,
318
7,81
3 15
,131
49
11
9 16
8 9,
900
8,38
3 18
,283
1996
8,11
3 10
,469
2,
658
490
3,14
8 7,
476
7,80
9 15
,285
48
10
1 14
9 10
,182
8,
400
18,5
82
1997
8,00
3 11
,086
2,
765
547
3,31
2 7,
631
8,01
3 15
,644
44
89
13
3 10
,440
8,
649
19,0
89
1998
7,82
9 12
,005
2,
900
577
3,47
7 7,
846
8,37
7 16
,223
47
87
13
4 10
,793
9,
041
19,8
34
1999
7,79
7 13
,400
3,
119
670
3,78
9 8,
362
8,96
1 17
,323
34
51
85
11
,515
9,
682
21,1
97
2000
7,83
6 15
,232
3,
371
783
4,15
4 9,
030
9,80
1 18
,831
35
48
83
12
,436
10
,632
23
,068
2001
7,71
3 16
,148
3,
581
917
4,49
8 9,
222
10,0
46
19,2
68
33
62
95
12,8
36
11,0
25
23,8
61
2002
7,40
2 15
,898
3,
654
977
4,63
1 8,
941
9,65
7 18
,598
25
46
71
12
,620
10
,680
23
,300
2003
7,11
7 15
,412
3,
720
1,04
9 4,
769
8,48
6 9,
211
17,6
91
23
40
63
12,2
29
10,3
00
22,5
29
2004
7,00
1 15
,553
3,
801
1,11
1 4,
912
8,45
1 9,
138
17,5
89
19
34
53
12,2
71
10,2
83
22,5
54
2005
6,82
2 16
,405
3,
948
1,18
3 5,
131
8,64
1 9,
397
18,0
38
20
38
58
12,6
09
10,6
18
23,2
27
2006
6,84
0 17
,912
4,
280
1,29
4 5,
574
9,15
3 9,
974
19,1
27
19
32
51
13,4
52
11,3
00
24,7
52
2007
6,96
219
,177
4,66
91,
475
6,14
49,
525
10,4
0719
,932
3231
6314
,226
11,9
1326
,139
2008
6,89
820
,307
5,10
11,
672
6,77
39,
658
10,7
2920
,387
1530
4514
,774
12,4
3127
,205
16
SuperviSion of the banking Sector
1.6. Impact of the change in the accounting standards for banking statistics
The re-casting of the prudential reporting in 2008 introduced the COREP (capital ratio) and FINREP
(financial reporting, balance sheet and profit and loss account) tables. The purpose of both reporting
frameworks developed by the Committee of European Banking Supervisors (CEBS) is, among others,
to lighten the administrative burden of banks by harmonising the reporting frameworks throughout
the EU. While the introduction of COREP was required under the Basel II regime, FINREP, which is
based on IFRS accounting standards, was introduced following a consultation of the industry, the
majority of which was in favour of a reporting based on IFRS standards.
The implementation of FINREP and COREP reporting frameworks on 1 January 2008 led to a break
in the banking statistics regarding the balance sheet, the profit and loss account and the solvency
ratio. This break is greater than the reading of the tables presented below could suggest and for
which the CSSF has maintained, as far as possible, the presentation of the previous years in order to
be able to compare the figures in a basic manner.
The change of the accounting standards affects the statistical tables in form as well as in
substance.
Regarding the form, the CSSF developed, via regular publications (Newsletter, website, annual
report), a model for the publication of the balance sheet and the profit and loss account which
maximally absorbs the consequences of the break in order to keep some historical and comparative
overview of the statistics.
Regarding the substance, however, the break cannot be easily avoided. This break should, therefore,
be taken into account during the interpretation of the development deriving from the presented
aggregated figures. Since the comparability of the data is reduced, the explanatory texts below in
this chapter, bring to the fore the various aspects which explain the developments shown by the
gross figures.
1.6.1. FINREP
FINREP (Financial Reporting), the common European reporting applicable since 1 January 2008,
differs from the prior reporting tables in substance as well as in form. It includes the balance
sheet, the profit and loss account and some other tables which are less important in this context.
Moreover, the CSSF receives additional information regarding the balance sheet and the profit and
loss account.
The former reporting framework under Lux-Gaap was based on an accounting framework which
was already harmonised at European level and which was of Continental European inspiration, with
the following main characteristics:
- the Lux-Gaap accounting framework resulting from the common European accounting principles
(cf. Directives 78/660/EEC, 83/349/EEC and 86/635/EEC);
- the presentation of the accounting situation focused on the “historical cost” decreased by possible
losses in value;
- the principle of prudence (the latent capital losses shall be provisioned, the latent capital gains
shall be ignored).
17
chapter i
The FINREP accounting framework is based on international IAS/IFRS accounting standards which
are characterised as follows:
- standards resulting from international works by the International Accounting Standards Board
(IASB) with a view to harmonising the accounting standards (cf. Regulation (EC) No 1606/2002 of
19 July 2002);
- the dominance of substance over form (the IFRS accounts show an economic reality rather than a
formal reality);
- the broader use of fair value; this valuation at market value results in the fact that latent gains
and losses are both taken into account and directly influence either the profit and loss account or
the balance sheet and/or accounting capital; the financial information is, thus, directed towards
the needs of possible investors (shareholder’s point of view);
- the goodwill is not amortised over a predefined period of time; only impairments are assessed in
accounting.
All these elements contribute that IAS/IFRS standards be a framework which should enhance
transparency of a company’s real economic value for investors and shareholders.
1.6.2. COREP
The new solvency ratio is defined in Circular CSSF 06/273 transposing the relevant provisions of
Directive 2006/48/EC (Capital Requirements Directive - CRD).
The main purpose of CRD is to introduce at European level the equivalent of the agreement on
international convergence of capital measurement and capital standards adopted on 26 June 2004
by the Basel Committee on Banking Supervision (Basel II) and published in July 2004.
In order to allow the supervisory authorities an easy supervision of the compliance with the new
capital adequacy regime applicable to credit institutions and investment firms, the new common
European reporting COREP (Common Reporting), drawn up by CEBS, was introduced at the
beginning of 2008.
• Definition of own funds under Basel II
The constituents of own funds remain roughly the same as for the former solvency ratio, but
prudential filters are added for the actual calculation of own funds. The purpose of these prudential
filters is to ensure that the prudential own funds observe certain qualitative standards specific to
their status, while they are based on accounting elements of own funds included in the balance
sheet which, in turn, must observe qualitative and formal standards.
Thus, prudential own funds must observe:
- a certain prudent approach, with a stability/absence of volatility of own funds;
- a quality marked with continuity;
- the availability to absorb losses;
- the reliability of the valuation.
• Capital requirements under Basel II
An important role is attributed to internal risk management systems of banks, which may be
substituted under certain conditions for exclusively “standard” approaches.
More flexible than the former solvency ratio and developed in close co-operation with authorities
represented in the Basel Committee and the industry, the new Basel II ratio presents three important
new characteristics:
18
SuperviSion of the banking Sector
- the possibility to use internal models to determine capital requirements for credit risk instead of
the standardised approach;
- the consideration of the operational risk;
- risk mitigation techniques which are more detailed under Basel II: these techniques are set up
on a basis of much larger instruments and elements, but the eligibility and consideration criteria
are far more binding (qualitative and legal standards to be observed) and the calculation and
monitoring methods much more detailed, and therefore complex, than for the former ratio.
While the methods for the calculation of exposures and requirements were unique for the former
ratio, the new ratio provides different methods which may be applied according to the needs and
competences of each bank. The choice of the methods and, where applicable, the internal models
used are validated and monitored by CSSF experts. It should be borne in mind that the chosen
methods must be applied permanently.
1.7. Development in the balance sheets
The balance sheet total of credit institutions of the financial centre set at EUR 930,857 million at the
end of 2008 against EUR 915,341 million at the end of 2007, which represents an increase of 1.7%
over the year.
Development in the balance sheet total of credit institutions – in billion EUR
1980 97.101981 125.951982 148.411983 163.411984 181.731985 189.091986 198.491987 215.321988 246.361989 281.041990 309.371991 316.091992 357.561993 397.151994 438.011995 455.471996 477.371997 516.591998 540.891999 598.012000 647.632001 721.982002 662.702003 655.602004 695.362005 791.252006 839.572007 915.342008 930.86
0
250
500
750
1000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
19
chapter i
As at 31 December 2008, the aggregated balance sheet was drawn up in accordance with two
guidelines:
- allow to compare as much as possible the figures of 2007 under Lux-Gaap with those of 2008
under FINREP based on the IAS/IFRS accounting framework;
- adjust as much as possible to a presentation line “counterparty type” although FINREP is directed
to “portfolio type”.
Aggregated balance sheet total – in million EUR
ASSETS 2007 2008(*) Variation LIABILITIES 2007 2008(*) Variation
Loans and advances to central banks and central governments
26,116 58,729 124.9% Amounts owed to central banks
38,662 46,865 21.2%
Loans and advances to credit institutions
445,783 427,179 -4.2% Amounts owed to credit institutions
400,823 429,565 7.2%
Loans and advances to customers
187,525 191,608 2.2% Amounts owed to customers
302,610 279,027 -7.8%
Financial assets held for trading
N/A 22,188 Amounts owed represented by securities
89,328 77,692 -13.0%
Fixed-income securities
207,797 194,693 -6.3% Liabilities (other than deposits) held for trading
N/A 21,840
Variable-yield securities
20,767 19,419 -6.5% Provisions 10,806 6,231 -42.3%
Fixed assets and other assets
27,354 17,040 -37.7% Subordinated debts
11,223 14,712 31.1%
Other liabilities 22,367 15,914 -28.9%
Equity 39,521 39,012 -1.3%
Total 915,341 930,857 1.7% Total 915,341 930,857 1.7%
(*) Preliminary figures
• Assets
Regarding assets, the growth of loans and advances to central banks and central governments
shows that certain banks seek security when choosing their counterparty following the distrust
which took hold of the financial markets in the fourth quarter of 2008. At the same time, the
investments on the interbank market decreased by 4.2% (- EUR 18.6 billion).
The loans and advances to customers are strikingly stable and show even a slight increase of 2.2%
(+ EUR 4 billion) as compared to the end of 2007.
20
SuperviSion of the banking Sector
Long-term development in loans and advances to customers – in billion EUR
Loans andadvances
to customers74.1 77.1 88.3 88.5 80.7 86.0 88.1 96.8 98.2 117.1 128.5 145.3 127.5 117.5 121.1 146.5 159.4 187.5 191.6
0
40
80
120
160
200
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
The 1.7% growth in the balance sheet total as compared to 2007, mainly results from the new item
“Financial assets held for trading” including mainly all derivatives which were reported in the off-
balance sheet under Lux-Gaap. These derivatives contributed, for a short time, to a record level of
the balance sheet total when it exceeded EUR 1,000 billion at the end of October 2008.
The 6.3% decrease (- EUR 13.1 billion) of fixed-income securities can be explained by the fall in the
stock markets which had a direct impact on the balance sheet positions, stated at fair value, under
the new accounting rules. Furthermore, certain banks reduced, as far as possible, their securities
portfolio in order to limit their leverage.
• Liabilities
Regarding liabilities, the 21.2% increase of the amounts owed to central banks (+ EUR 8.2 billion as
compared to 2007) proves that credit institutions greatly use this financing means.
The amounts owed to credit institutions show an increase of EUR 28.7 billion (+7.2%), which is
exceptional in the context of liquidity crisis and reveals the quality perceived in the banks of the
financial centre. The use of interbank financing did not engender a pressure on the interest-rate
margin as the analysis of the results shows in point 1.8. below.
The new item “Liabilities (other than deposits) held for trading” includes mainly the derivatives
undergoing a latent capital loss. In general, they are counterparty of reverse transactions which are
included in item “Financial assets held for trading”.
Under the effects of the new IAS/IFRS accounting standards which do not recognise anymore the
AGDL provisions and the lump sum provision, the item provisions records a decrease of EUR 4.6
billion (-42.3%).
21
chapter i
Structural balance sheet
ASSETS 2007 2008(*) LIABILITIES 2007 2008(*)
Loans and advances to central banks and central governments
2.85% 6.31% Amounts owed to central banks
4.22% 5.03%
Loans and advances to credit institutions
48.70% 45.89% Amounts owed to credit institutions
43.79% 46.15%
Loans and advances to customers
20.49% 20.58% Amounts owed to customers
33.06% 29.98%
Financial assets held for trading
N/A 2.38% Amounts owed represented by securities
9.76% 8.35%
Fixed-income securities
22.70% 20.92% Liabilities (other than deposits) held for trading
N/A 2.35%
Variable-yield securities
2.27% 2.09% Provisions 1.18% 0.67%
Fixed assets and other assets
2.99% 1.83% Subordinated debts 1.23% 1.58%
Other liabilities 2.44% 1.71%
Equity 4.32% 4.19%
Total 100.00% 100.00% Total 100.00% 100.00%
(*) Preliminary figures
1.8. Development in the profit and loss account
Net profit of the Luxembourg banking sector in 2008 reached EUR 564 million, which represents an
88.1% fall compared to the previous year. This drop takes place in the context of the international
economic and financial crisis together with a heavy depreciation of financial assets.
Three big trends impacted on the profit and loss account of Luxembourg credit institutions during
2008:
- the good liquidity situation of the financial centre in its entirety which is reflected by the strong
growth of interest margin;
- the depreciation of certain financial assets resulting in a significant decline of the income from
financial operations and a substantial increase in the creation of provisions;
- the difference in performance of the banks from the financial centre; in particular six institutions,
particularly exposed to capital markets, totalled three quarters of the decline of the aggregated
income over a year.
22
SuperviSion of the banking Sector
Development in the profit and loss account – in million EUR
Variation 2007/2008
2007 Relativeshare
2008(*) Relativeshare
in volume in %
Interest-rate margin 6,002 55% 7,416 71% 1,414 23.6%
Net commissions received 4,010 37% 3,726 36% -283 -7.1%
Other net income 964 9% -728 -7% -1,692 -175.5%
Banking income 10,976 100% 10,414 100% -562 -5.1%
Costs 4,420 40% 4,564 44% 144 3.2%
of which: staff costs 2,372 22% 2,471 24% 100 4.2%
of which: general administrative expenses
2,048 19% 2,092 20% 44 2.1%
Result before depreciation 6,556 60% 5,851 56% -706 -10.8%
Net depreciation 1,038 9% 4,997 48% 3,959 381.5%
Taxes 780 7% 289 3% -490 -62.9%
of which: income N/A -732
of which: expenses N/A 443
Net result for the financial year
4,739 43% 564 5% -4,175 -88.1%
(*) Preliminary figures
The interest-rate margin, which amounted to EUR 7,416 million as at 31 December 2008, increased
by 23.6% as compared to the previous year. This rise, similar to the one in 2007, proves the good
liquidity situation of the whole Luxembourg banking sector. Throughout 2008, the liquidity surplus
from the asset management, exercised in the financial centre, allowed Luxembourg banks to gather
substantial liquidity premiums increased by the financial crisis.
Yet, this EUR 1,414 million increase of the interest-rate margin was not sufficient to offset the
decrease in other items of operating income. The sluggish stock market depressed the income
from the portfolio management and brokerage. Thus, the commission income declined by EUR
283 million year-on-year. The decline of the income is sharper for other net incomes which include
value variations of trading-book securities and which fall by EUR 1,692 million as compared to 31
December 2007. This decrease shows the effects of the value decrease recorded in particular for
financial assets in 2008.
Consequently, banking income, i.e. the whole operating income, decreases by 5.1% as compared
to 31 December 2007. Given the 3.2% increase in costs, profit before provisions falls by EUR 706
million (-10.8%).
The net impairment increased by EUR 3,959 million year-on-year. This amount mainly represents the
impairment for non-trading book assets, which became necessary because of the depreciation of
financial instruments due to the economic and financial crisis. By adding the capital loss recorded in
the trading book, the estimated amount of financial charge from the crisis, borne by the profit and
loss accounts of Luxembourg credit institutions, is valued at approximately EUR 6 billion in 2008.
The 62.9% reduction in the tax charges is explained by the possibilities offered by IFRS standards
to activate future tax charges by crediting the tax expenses account. Indeed, according to IFRS
standards, an undertaking which reports a loss for a financial year may, during that financial year,
take into its result the tax charges avoided for the financial years to come in the form of positive
tax expenses.
23
chapter i
By removing these positive tax expenses, mainly recorded by those six banks reporting important
losses, a real tax charge of EUR 732.3 million remains and the decrease is then only 6.1%.
It should be borne in mind that the sharp decline of 88.1% in one year in the aggregated net result
hides great differences in performance by the banks of the financial centre. For three quarters of
the credit institutions, the profit and loss account shows a positive net result in 2008. Amongst the
banks with losses, seven institutions, more exposed to the capital markets affected by the crisis,
have a net result in decrease by more than EUR 3 billion in a year.
Long-term development of profit and loss account – in million EUR
2001 2002 2003 2004 2005 2006 2007 2008(*)
Interest-rate margin
4,383 4,141 4,080 3,913 3,905 4,830 6,002 7,416
Net commissions received
2,793 2,615 2,533 2,771 3,209 3,674 4,010 3,726
Other net income
672 1,258 942 734 1,140 2,296 964 -728
Banking income 7,848 8,014 7,554 7,418 8,255 10,800 10,976 10,414
Costs -3,624 -3,490 -3,385 -3,461 -3,693 -3,981 -4,420 -4,564
of which: staff costs
-1,759 -1,809 -1,752 -1,798 -1,945 -2,160 -2,372 -2,471
of which: general administrative expenses
-1,866 -1,681 -1,632 -1,663 -1,748 -1,821 -2,048 -2,092
Result before depreciation
4,224 4,524 4,170 3,957 4,562 6,819 6,556 5,851
Net depreciation
-536 -1,166 -637 -344 -296 -305 -1,038 -4,997
Taxes -826 -638 -658 -746 -768 -843 -780 -289
Net result for the financial year
2,862 2,720 2,874 2,866 3,498 5,671 4,739 564
(*) Preliminary figures
Structural ratios
2007 2008(*)
Cost / income ratio 40.3% 43.8%
Profit before taxes / assets 0.6% 0.1%
Profit before taxes / risk-weighted assets 26.0% 4.3%
Profit before taxes / tier-1 capital 17.1% 2.9%
Interest-rate margin / banking income 54.7% 71.2%
Income excluding interest / banking income 45.3% 28.8%
(*) Preliminary figures
24
SuperviSion of the banking Sector
Development of certain indicators of the profit and loss account per employee
(in million EUR) 2006 2007 2008(*)
Banking income / employee 0.438 0.420 0.383
Staff costs / employee 0.087 0.091 0.091
(*) Preliminary figures
1.9. Off-balance sheet items and derivative financial instruments
The banks of the financial centre used derivative financial instruments for a nominal amount of
EUR 830 billion in 2008 against EUR 1,027 billion in 2007. The use of derivative financial instruments
thus decreased by 19% as compared to 2007. Following sustained increases of 6.5% in 2003, 14.4%
in 2004, 14.1% in 2005 and 7.7% in 2006 and the almost stagnation in 2007 (+0.5%), derivative
financial instruments only represented 89.2% of the balance sheet total in terms of volume in 2008.
Compared to the previous years, this percentage clearly decreased (112.2% in 2007 and 121.6% in
2006).
The transactions related to interest rate remain the most used type of transaction representing 55%
of the total nominal volume of the transactions in derivatives (60% in 2007). Their EUR 163 million
decrease in volume is crucial for the total decline in volume of derivative financial instruments.
Among the transactions related to interest rate, options and futures remain marginal and loose in
relative importance. Interest rate swaps, which are considered to be classic derivatives, represent
97% of EUR 457 billion, the total amount of the transactions related to interest rate.
Transactions related to title deeds (in the form of options or futures) still represent only 5% of the
total nominal volume of the transactions in derivatives (3% in 2007). Their slight increase in relative
importance is rather attributable to the fact that the two other transaction categories are slightly
decreasing.
The transactions related to exchange rates fell by 11% and amount to EUR 334 billion at the end of
2008 against EUR 374 billion in 2007. This drop is entirely attributable to forward foreign exchange
transactions (-EUR 65 billion, i.e. -19%), the quota of which, nevertheless, remains the highest at
84% (92% in 2007). Options on exchange rates (EUR 20 billion) and cross-currency interest rate
swaps (EUR 34 billion) rose slightly compared to the previous year and represent the remaining
16% of the total volume of the transactions related to exchange rates, whereas their part was much
more marginal in 2007 with 7%.
Assets deposited by customers: off-balance sheet
(in billion EUR) 2007 2008(*) Variation
Assets deposited by UCIs 1,993.7 1,503.5 -24.6%
Assets deposited by clearing or settlement institutions
490.9 470.5 -4.2%
Assets deposited by other professionals acting in the financial markets
6,084.7 6,375.3 4.8%
Other deposited assets 417.8 263.2 -37.0%
(*) Preliminary figures
25
chapter i
Use of derivative financial instruments by credit institutions
Variation Structure
Notional amounts(in billion EUR)
2007 2008(*) in volume
in % 2007 2008
Transactions related to interest rate
621 457 -163 -26% 60% 55%
of which: options 32 4 -28 -87% 5% 1%
of which: interest rate swaps 557 444 -114 -20% 90% 97%
of which: future or forward rate agreements (FRA)
4 5 1 18% 1% 1%
of which: interest rate futures 27 4 -22 -84% 4% 1%
Transactions related to title deeds
32 39 6 20% 3% 5%
of which: futures 20 20 0 1% 61% 51%
of which: options 13 19 6 48% 39% 49%
Transactions related to exchange rates
374 334 -40 -11% 36% 40%
of which: forward foreign exchange transactions
345 280 -65 -19% 92% 84%
of which: cross-currency IRS 20 34 15 73% 5% 10%
of which: options 9 20 11 117% 2% 6%
Total 1,027 830 -197 -19% 100% 100%
(*) Preliminary figures
1.10. Development in own funds and in the solvency ratio
1.10.1. Number of banks required to meet a solvency ratio
As at 31 December 2008, the number of banks required to meet a non-consolidated solvency ratio
stood at 112, including 111 banks incorporated under Luxembourg law and one branch of non-EU
origin. 94 banks carry out limited trading activities, and are therefore authorised to calculate a
simplified ratio. Actual trading activities remain confined to a limited number of banks. Among
the 29 banks that also calculate a consolidated solvency ratio, twelve are required to calculate an
integrated ratio.
Number of banks required to meet a solvency ratio
Integrated ratio Simplified ratio Total
2007 2008 2007 2008 2007 2008
Non-consolidated 11 18 103 94 114 112
Consolidated 10 12 21 17 31 29
1.10.2. Development in the solvency ratio
Since 1 January 2008, banks must observe the solvency ratio called Basel II and use the related
harmonised reporting framework COREP. The main changes from the Basel I ratio are stated in
point 1.6.2. above.
The figures below are based on consolidated figures for banks required to meet a consolidated
solvency ratio. Data from 2007 were adapted in order to allow them to be compared to data from
2008 based on the new COREP reporting framework.
26
SuperviSion of the banking Sector
• Aggregated ratio
Notwithstanding the fact that the framework to calculate the solvency ratio changed in 2008, the
aggregated ratio at the end of 2008 is almost similar to the one in 2007, namely 14.7%, exceeding
easily the minimum threshold of 8% required under the existing prudential regulations. This
continuity is essentially due to the existence of a minimum threshold still to be applied in 2008 and
2009, which was introduced by the authors of Basel II in order not to experience a fast decrease
in capital requirements. Without this minimum threshold, the ratio would reach 15.5% in 2008.
Considering only core equity capital (Tier 1), the aggregated ratio for the financial centre fell from
12.1% at the end of 2007 to 11.9% at year-end 2008.
• Own funds
For the components of Tier 1, representing still over 83% of the ratio’s numerator with EUR 31,704.9
million (EUR 32,206.9 million in 2007), we note a 15.4% increase of the paid-up capital compared to
2007. Indeed, some banks increased their capital basis at year-end 2008 in order to better manage
the effects of the financial crisis. The position “Silent participation” (Stille Beteiligungen) (and
assimilated) falls by EUR 354.2 million (i.e. -20%), mainly due to the reimbursement of a matured
“Stille Einlage”.
In addition, the deductions to be applied on original own funds increased and amount to EUR
1,089.3 million in 2008, against only EUR 855.9 million in 2007. The new position “Other deductions
from original own funds”, including, among others, the deductions caused by the first adoption of
IFRS standards, amount to EUR 479.3 million in 2008.
Tier 2 amounts to EUR 6,301.3 million in 2008, against EUR 6,690.6 million in 2007, following
the impact of the 26.6% decrease of cumulative preference shares without fixed maturity and
subordinated upper Tier 2 debt instruments, and having regard to applicable upper limits and
deductions. Thus, Tier 2 represents 16.5% of the numerator of the solvency ratio in 2008, against
17.2% in 2007.
Tier 3, i.e. sub-additional own funds, remains very marginal even if the relative share in own funds
increases to 0.7% in 2008.
• Capital requirements
The overall capital requirements fall by 0.6% due to the effects of the decrease of the credit risk
requirements, partially compensated by the increase of other requirements and by the introduction
of the capital requirement against operational risk.
The requirement to cover credit risk remains the most important item of the requirements and
totals EUR 18,027.1 million in 2008 against EUR 20,778.7 million in 2007, representing a decrease
of 13%. It was, indeed, predictable that the new Basel II framework would cause a decrease of the
capital requirements.
Capital requirements to cover interest rate risk, risks in relation to equities, risks in relation to
commodities, capital requirements according to the internal model and capital requirements against
settlement/delivery risk remain marginal.
Operational risk is covered under the new solvency ratio Basel II for the first time. It is defined as the
risk of loss resulting from inadequate or failed processes, personnel and internal systems or external
events. Capital requirements against operational risk amount to EUR 1,501.5 million.
27
chapter i
“Other capital requirements” existed, in principle, already under the former ratio, but they were
marginal. For the purpose of CSSF’s Annual Report, the requirements were aggregated with other
requirements under the item “Requirement to cover trading risk”. If the other requirements as
such remained marginal, the amount for 2008 includes nevertheless another element unique and
exceptional in size, i.e. additional capital requirements under the threshold level. This requirement,
to be calculated only for 2008 and 2009, is intended to avoid a sharp fall of capital requirements
following the first applications of the new calculation method. Thus, the amount of EUR 1,574.7
million is a consequence of the effects of the decline in capital requirements against credit risks
induced by the new methods explained above.
(in million EUR)
NUMERATOR 2007 2008
Original own funds 33,994.6 34,808.9
Paid-up capital 11,153.5 12,876.4
Silent participation (“Stille Beteiligungen”) 1,771.4 1,417.2
Share premium account, reserves, profits and losses brought forward and from the current financial year, funds for general banking risks and minor interests
21,069.7 20,515.3
including prudential filters N/A 915.5
Items to be deducted from original own funds -1,767.4 -3,104.0
Own shares -0.2 -1.3
Intangible assets -931.7 -1,534.0
Deductions from original own funds 855.9 -1,089.3
Other deductions from original own funds N/A -479.3
ORIGINAL OWN FUNDS (Tier 1) 32,206.9 31,704.9
Additional own funds before capping 7,514.2 7,686.9
Upper Tier 2 4,120.8 3,845.6
of which part of own funds instruments exceeding the limits for the inclusion in the original own funds and integrated in Tier 2
N/A 136.6
of which prudential filters N/A 1,366.4
of which cumulative preference shares without fixed maturity and Upper Tier 2 subordinated debt instruments
3,023.8 2,220.1
Lower Tier 2: Lower Tier 2 subordinated debt instruments and cumulative preference shares with fixed maturity
3,393.4 3,841.3
Additional own funds after capping 7,460.2 7,280.8
Deductions from additional own funds 769.5 979.4
ADDITIONAL OWN FUNDS after capping and after deductions (TIER 2)
6,690.6 6,301.3
Sub-additional own funds before capping 68.6 463.2
SUB-ADDITIONAL OWN FUNDS after capping (TIER 3) 33.3 274.5
OWN FUNDS BEFORE DEDUCTIONS (T1 + T2 + T3) 38,930.9 38,280.7
Deductions from the total of own funds N/A -123.2
ELIGIBLE OWN FUNDS 38,930.9 38,157.5
28
SuperviSion of the banking Sector
DENOMINATOR
TOTAL CAPITAL ADEQUACY REQUIREMENT 21,203.5 21,327.7
Requirement to cover credit risk 20,778.7 18,027.1
Requirement to cover foreign exchange risk 101.1 75.8
Requirement to cover interest rate risk 303.6 106.5
Requirement to cover the risk in relation to equities 16.9 18.2
Requirement to cover the risk in relation to commodities 0.0 2.3
Requirement according to internal models 3.2 21.3
Requirement to cover settlement/delivery risk 0.0 0.3
Requirement to cover operational risk N/A 1,501.5
Other capital adequacy requirements (amongst others exceeding large exposures, threshold, etc.)
0.0 1,574.7
RATIO
Solvency ratio (base 8%)1 14.7% 14.3%
Solvency ratio (base 100%)2 183.6% 178.9%
Tier 1 Ratio (base 8%)3 12.1% 11.9%
Tier 1 Ratio (base 100%)4 151.9% 148.7%
The graph below plots the development of the solvency ratio (base 8%) since 1990. The weighted
average is the ratio of total eligible own funds in the financial centre and total weighted risks. This
average takes into account credit institutions according to their business volume.
Development in the solvency ratio (base 8%)
0%
5%
10%
15%
20%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008Weighted
average 8.9% 10.3% 11.2% 11.5% 12.1% 12.6% 12.5% 12.4% 12.4% 13.3% 12.0% 12.7% 14.3% 16.5% 16.5% 15.2% 14.7% 14.7% 14.3%
The introduction of the IAS/IFRS accounting standards did not have a negative impact on the
volatility of own funds, thanks to the prudential filters. The aggregated ratio remains stable, at
a comfortably high level, which also reflects the increasing concerns in optimal allocation of own
funds under profitability constraints.
1 Eligible own funds/(Total capital adequacy requirement * 12.5)2 Eligible own funds / Total capital adequacy requirement 3 (Original own funds - Items to be deducted from original own funds) / (Capital adequacy requirement * 12.5)4 (Original own funds - Items to be deducted from original own funds) / Capital adequacy requirement
29
chapter i
1.10.3. Development in the solvency ratio distribution (base 8%)
In non-aggregated terms, the high solvency ratio is due to a limited number of banks whose ratio is
situated within the weak capitalisation bands, i.e. below 10%. For instance, as at 31 December 2008,
the percentage of banks with a solvency ratio below this 10% threshold was only 14%. Conversely,
50% of credit institutions of the financial centre recorded a solvency ratio exceeding 15%. However,
this figure decreased slightly compared to 31 December 2007, when it exceeded 51% or compared
to the end of 2006, when it exceeded 57%.
Development in the solvency ratio (base 8%)
2007 2008
Ratio Number of banks
as % of total Number of banks
as % of total
<8% 0 0% 1 1%
8%-9% 6 5% 5 4%
9%-10% 13 11% 10 9%
10%-11% 6 5% 8 7%
11%-12% 8 7% 6 5%
12%-13% 5 4% 11 10%
13%-14% 11 10% 9 8%
14%-15% 6 5% 7 6%
15%-20% 20 18% 24 21%
>20% 39 34% 31 29%
Total 114 100% 112 100%
One bank whose solvency ratio was below the 8% limit at the closing of 2008, received a substantial
capital increase at the beginning of 2009 so that the ratio exceeds again the minimum threshold
imposed.
1.11. International expansion of Luxembourg banks
Number of branches established in the EU/EEA as at 31 December 2008
Country Luxembourg branches established in the EU/EEA
Branches of EU/EEA banks established in Luxembourg
Austria 2 -
Belgium 6 -
Finland - 1
France 1 4
Germany 3 16
Greece 1 -
Ireland 3 1
Italy 4 1
Netherlands 1 2
Portugal 2 2
Spain 5 -
Sweden 1 1
United Kingdom 3 4
Total 33 325
5 Including an EU financial institution according to Article 31 of the law of 5 April 1993 on the financial sector, as amended.
30
SuperviSion of the banking Sector
Freedom to provide services within the EU/EEA as at 31 December 2008
Country Luxembourg banks providing services in the EU/EEA
EU/EEA banks providing services in Luxembourg
Austria 33 25
Belgium 55 22
Bulgaria 11 -
Cyprus 16 3
Czech Republic 16 -
Denmark 35 8
Estonia 15 1
Finland 32 9
France 59 68
Germany 59 46
Gibraltar 2 5
Greece 31 2
Hungary 16 6
Iceland 5 2
Ireland 31 31
Italy 45 8
Latvia 15 -
Liechtenstein 2 2
Lithuania 15 1
Malta 14 4
Netherlands 48 27
Norway 14 3
Poland 21 2
Portugal 32 8
Romania 13 -
Slovakia 16 1
Slovenia 16 -
Spain 48 5
Sweden 31 5
United Kingdom 46 92
Total number of notifications
793 386
Total number of banks concerned
73 386
1.12. Banks issuing mortgage bonds (Banques d’émission de lettres de gages, Pfandbriefbanken)
Like the majority of the banks of the financial centre, banks issuing mortgage bonds were also
affected by the financial and economic crisis. Apart from the fact that the assets of these banks
suffered a certain market value reduction despite their quality, the general instability of the financial
markets prevented the banks issuing mortgage bonds to launch important new issues, so that the
banks contented themselves with the execution of more moderate issues or the sole management
of their existing cover assets.
Despite the effects of the crisis, a new player, namely the Luxembourg branch of German origin,
Dekabank Deutsche Girozentrale, Zweigniederlassung Luxemburg, intends to issue public mortgage
31
chapter i
bonds. A notification regarding the launch of this activity by the branch was sent to the Luxembourg
and German supervisory authorities. The branch is subject to all the provisions of Articles 12-1 to
12-9 of the law of 5 April 1993, as amended; however, some softening regarding Article 12-8(5)
is provided (cf. below). The legal framework providing the issue of mortgage bonds via a branch
was established by the law of 24 October 2008 improving the legal framework of the Luxembourg
financial centre (cf. below for a brief description of the amendments introduced). At the moment,
the bank has not yet completed its first issue. It should be borne in mind that other banks also
showed interest in issuing mortgage bonds via their Luxembourg branch.
Due to the market difficulties, the positive development of the balance sheet total and the volume
of mortgage bonds issued was quite moderate. As at 31 December 2008, the balance sheet of the
five banks issuing mortgage bonds totalled EUR 52.8 billion (against EUR 50.6 billion at the end
of 2007). The total of public-sector mortgage bonds issued (and in circulation) by those five banks
amounted to EUR 34.1 billion compared to EUR 32.6 billion at the end of 2007.
Issues of mortgage bonds are guaranteed by ordinary cover assets and by substitute cover assets.
As at 31 December 2008, public sector mortgage bonds in circulation benefited from an over-
collateralisation (nominal value) of EUR 7.9 billion. Over-collateralisation calculated according to
the current value amounted to EUR 3.7 billion as at 31 December 2008.
The ordinary cover assets of public sector mortgage bonds, for the five issuing banks, break down
as follows:
- claims on or guaranteed by public organisations: EUR 11.97 billion;
- bonds issued by public organisations: EUR 15 billion;
- public sector mortgage bonds of other issuers: EUR 7.9 billion;
- derivative transactions: EUR 4.6 billion.
Besides these ordinary cover assets, the banks used substitute cover assets to cover their public
sector mortgage bonds amounting to EUR 2.5 billion as at 31 December 2008.
Erste Europäische Pfandbrief- und Kommunalkreditbank, Aktiengesellschaft in Luxembourg
continued to be the only bank issuing mortgage bonds (lettres de gage hypothécaires). The cover
assets of these mortgage bonds are exclusively made up of other mortgage bonds complying
with the provisions of Article 43(4) of the law of 20 December 2002 on undertakings for collective
investment, as amended. As at 31 December 2008, the total volume of mortgage bonds issued
reached EUR 150 million; these bonds are guaranteed by cover assets worth EUR 163 million. Over-
collateralisation (nominal value) represented EUR 13 million, while over-collateralisation according
to the current value was EUR 12.8 million as at 31 December 2008.
Owing to the faultless quality of investments of specialised banks and the scale of over-
collateralisation in relation to the mortgage bonds issued, public sector mortgage bonds continue
to receive an AAA rating from rating agencies.
• Law of 24 October 2008 improving the legal framework of the Luxembourg financial centre
As time went by, a certain number of issues of the legislation needed an adaptation. Thus, together
with the players in the financial centre, the CSSF elaborated a bill modernising the provisions of
the law of 5 April 1993 on the financial sector, as amended, relating to the banks issuing mortgage
bonds. The new text was voted on 15 October 2008 and introduced the following amendments:
a) Introduction of new mortgage bond types
Until now, the provisions of the law of 5 April 1993, as amended, on banks issuing mortgage
bonds, included only two mortgage bond types, i.e. public sector bonds and mortgage bonds.
Given the development of foreign legislation in this field, the banks may, pursuant to the new text,
32
SuperviSion of the banking Sector
finance assets such as aircrafts, ships, objects relating to railways, etc., and refinance them with
moveable-property bonds, provided that one may exercise rights in rem in these assets or charges
on these assets and enter them in a public register in a Member State of the European Union, the
European Economic Area or the OECD and that these charges confer a right on the property that is
capable of being asserted against third parties.
In order to provide the banks with flexibility regarding the choice of assets, the possible assets are
not listed in an exhaustive and limitative manner in the text; however, Article 12-1 is completed by a
paragraph which provides that a bank may finance these assets as long as it observes the conditions
set out in the law.
The launch of this new category of moveable-property bonds is subject to prior approval by the
CSSF. The definition, nature and practical proposals regarding each category will be set at that
moment by the CSSF. Moreover, for the purpose of transparency and legal certainty, a new separate
collateral is provided for each new category of moveable-property bonds.
b) Luxembourg mortgage bonds issued by a branch
The new law clarifies the case of Luxembourg mortgage bonds being issued by a Luxembourg branch
of an EU credit institution. In that case, the powers of the CSSF set out in Article 12-8(5), indents
1, 3, 5 and 6 concerning the management of collateral in case of reorganisation or liquidation of
the bank issuing mortgage bonds, are exercised by the liquidator appointed by the authorities of
the home Member State. In principle, this liquidator shall comply with the specific provisions of
Luxembourg law.
c) Inclusion of securitisation structures in the collateral
The banks are now authorised to include tranches of issues in the different collaterals which were
realised in the context of securitisations composed of eligible assets for the collateral, provided that
this collateral does not include more than 10% of non-eligible assets, since a proliferation of the
securitisation structures was observed over the last years and in order not to put at a disadvantage
the Luxembourg financial centre compared to the practices of other countries and to take into
account the fact that securitisations often comprise eligible and non-eligible assets for the collateral.
Moreover, in order to guarantee the quality of mortgage bonds, the securities issued by these
vehicles must have at least AA- rating (Standard & Poor’s) or AA3 (Moody’s).
d) Withdrawal of the principle of direct access to mortgage guarantees
In order to promote the development of the mortgage bond market, the new law withdrew the
principle of direct access to mortgage guarantees and allows the inclusion of mortgage debts for
which charges on real property are held by another bank on behalf of the bank issuing Luxembourg
mortgage bonds in the mortgage bonds’ collateral. Thus, in their assets, the banks may include
participations in syndicated lending as well as open and silent sub-participations in mortgage
credits granted to other banks established in a Member State of the European Union, the European
Economic Area or the OECD. The mortgage debts shall, nevertheless, fulfil the requirements
concerning “rights in rem in immoveable property” and “charges on real property” as laid down in
Article 12-1, indent 4 of the law of 5 April 1993, as amended.
e) Implementation of a 2% over-collateral rate
In order to increase the protection of bondholders in case of liquidation of a bank issuing mortgage
bonds, the nominal and the current value of the collateral must, henceforth, permanently exceed
the nominal value, respectively the current value of the mortgage bonds in circulation by 2%.
33
chapter i
Besides these essential amendments, the new text also provides less important amendments, such as:
- the explicit precision to include securities guaranteed by public entities of the European Union,
the European Economic Area or the OECD in the collateral;
- the inclusion of credits guaranteed by other commitments of the public sector as for example
public private partnerships;
- the precision regarding the access to guarantees (for the collateral, a bank may only use public
debts eligible at any time and for which there are no exceptions from the basic relation giving rise
to this debt);
- the withdrawal of the specific limitation of 60 times the own funds so that the banks may issue
mortgage bonds beyond this limit, and
- the increase up to 80% of the maximum rate of the estimated value of the realisation of residential
real estate which may be included in the collateral.
2. pruDential SuperviSory practice
2.1. The impact of the financial crisis on prudential supervision
Given the historic aspect of the financial crisis, the efficiency of the banking regulation must be
questioned. Before answering this question, the origin of the current financial crisis in the European
banking sector should be briefly presented.
Under the pressure of their shareholders who required a greater profitability, a certain number of
European banks increased the volume of transactions by taking into their balance sheet risks, the
quality of which turned out to be less high than initially estimated. Other banks followed expansion
strategies which turned out to be catastrophic in a crisis situation.
2.1.1. A defaulting regulatory framework?
The regulation in force in Luxembourg mainly consists in the authentic transposition of European
directives. Only the issue of liquidity is subject to national regulation.
It has to be noted that the extremely detailed European regulation on solvency and large exposure
limits did not prevent the historic financial crisis. The banking sector does certainly not suffer from
a lack of regulation but from an excess of rather inefficient regulation. The degree of detail and
complexity of the existing regulation absorbs an important part of the supervisory capacities,
without any improvement to the quality of the supervision.
Today, it is widely acknowledged that the solvency ratios Basel II and Basel I allowed an overly
important leveraging. Furthermore, Basel II suffers from the fact that capital requirements may
be calculated either by using internal models or by basing on external ratings. It is more and more
accepted that the absolute leveraging of the banks should be limited by using simple tools like, for
example, the ratio between original own funds and the balance sheet and off-balance sheet total.
Based on mathematical models, Basel II regulations provide the illusion that the regulation is an
exact science capable of precisely defining the capital amount necessary to cover future losses.
However, the regulation like the bank management is a matter of common sense rather than
mathematics.
The IFRS accounting standards spread by the European Commission are not such as to increase the
stability of the banking sector (which, as a matter of fact, was not the aim). IFRS standards are of
Anglo-Saxon inspiration and their main purpose is to determine the value of an undertaking from
the point of view of the investing shareholder. The European Union forced the listed undertakings
to publish their consolidated accounts using IFRS with the Regulation (EC) No 1606/2002. The
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SuperviSion of the banking Sector
accounting standards based on the European Directive 86/635/EEC which was of Continental
European inspiration and elaborated for the creditors’ protection, cannot, therefore, be used any
more by big banking groups.
The main deficiencies of IFRS standards are the prohibition to set up anti-cyclical provisions and
the possibility to maintain the non value items in the assets of the balance sheet, like goodwill and
differed taxes.
Finally, even though the harmonised European regulation was greatly incapable to avoid an
unprecedented financial crisis, the option to impose regulation in Luxembourg which goes beyond
the European rules would harm the competition of the financial centre and should therefore be
excluded.
2.1.2. An inefficient supervision?
The CSSF must reflect on the question whether a different methodology of prudential supervision
would have avoided or reduced the effects of the financial crisis. Before answering this question,
the missions regarding prudential supervision entrusted to the CSSF by the legislator should be
pointed out. According to Article 3 of the law of 23 December 1998 establishing a financial sector
supervisory commission, as amended: “The CSSF shall [...] carry out prudential supervision of
undertakings and persons coming under its authority in accordance with the laws and regulations
governing such supervision”.
Pursuant to Article 43 (“Purpose of supervision”) of the law of 5 April 1993 on the financial sector,
as amended: “The CSSF shall monitor the application of the laws and regulations relating to the
financial sector by the persons subject to its supervision.”.
It is generally admitted that the purpose of the prudential supervision is the protection of the public’s
savings. It is of course an obligation of due care and not an obligation to achieve a given result.
Pursuant to the above-mentioned Article 43, the prudential supervision is exclusively exercised in
the public interest. Thus, the prudential supervision is not exercised to guarantee the interest of
individual professionals, their clients or third parties.
The mission, as it is set by the legislator, is likely not to live up to the public’s expectations regarding
the CSSF’s mission and which aspires to the absence of any banking deficiency. Reducing this
expectation gap would, however, entail a big change in the methodology of supervision which
would then no longer be limited to the control of the compliance with the standards, but which
would directly and severely intervene in the commercial decisions of the banks, or even question
entire business models.
Given the experience of the financial crisis, it becomes more and more conspicuous that the regulator
must, in some cases, intervene directly in the banks’ commercial policies. Nevertheless, the problems
generated by such a supervisory method should be borne in mind:
- The current legislation does not expressly provide the CSSF with such a right. The CSSF only has
the right to request a capital surplus as compared to the minimum required when the process of
prudential review brings a negative decision.
- In a market economy which is composed of private banks, the banks shall define their own risk
profile and appetite. It will be extremely difficult to determine the appropriate timing of the
regulator’s intervention.
- It would be wrong to think that the CSSF agents are generally in a better position to express
judgment on the commercial policies than the managers of the banks themselves.
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- The direct intervention in the commercial policies includes the risk of bad assessment, either by
omitting to intervene when it was needed or by intervening without justification.
- The intervention in commercial policies will comply with difficulty with the principle of equal
treatment of banks before the regulation.
- A withdrawal of responsibility of the banks’ management bodies should be avoided. The regulator
cannot become manager of banks.
Finally, even if the public opinion might be disappointed, it should be noted that prudential
supervision has limits and that it cannot prevent all banking deficiencies or avoid financial crises
induced by the burst of speculative bubbles. The purpose of the banking prudential supervision is to
reduce as much as possible the number of the banks’ bankruptcies; they cannot be totally avoided.
In a market economy, the disappearance of inefficient banks must be possible, even through
bankruptcy. But the negative effects on the public’s savings must still be neutralised, as far as
possible, which is only possible with an efficient deposit guarantee scheme.
A characteristic of the Luxembourg financial centre is that the banking players are generally part of
a group in which they have a specific role. In agreement with the representatives of the industry and
pursuant to the possibilities offered by EU legislation, the CSSF never exercised ring fencing around
Luxembourg subsidiaries which means that problems which can arise in a group will inevitably
affect the Luxembourg bank.
Nevertheless, the CSSF will, in principle, be reluctant to approve projects which include the reception
of deposits from the public abroad, be it via subsidiaries or via internet, because of the risks such
models create for the deposit guarantee scheme. Pursuant to the principle of legal certainty, the
CSSF however cannot question the existing models based on such a concept.
2.2. Monitoring of quantitative standards
In order to ensure financial stability and risk spreading, credit institutions must observe the following
quantitative standards:
- evidence of minimum equity capital;
- a maximum ratio between own funds on the one hand and capital requirements on the other
hand;
- limitation of the risk concentration to a single debtor or a group of associated debtors;
- liquidity ratio;
- limitation of qualifying holdings.
In 2008, the CSSF intervened once in writing regarding the non-compliance with the capital ratio.
In this specific case and pursuant to the legal provisions in force, the credit institution informed the
CSSF of a temporary non-compliance with the solvency ratio and of its will to restore the situation
as soon as possible. The CSSF requested that the necessary measures be taken to sort out the
situation.
Furthermore, the CSSF had to take measures three times regarding failure to meet the liquidity ratio.
The CSSF stressed that the liquidity ratio shall be complied with at all times and that in case of non-
compliance the banks concerned shall inform the CSSF. The CSSF may then authorise a temporary
non-compliance with the ratio and grant a time limit to the bank in order to remedy the situation.
In each case where one of the two above-mentioned ratios was not met, the CSSF required the
institution concerned to provide information on the measures taken to remedy the situation. The
situations have been sorted out either immediately or within the allocated time frame where
acceptable explanations could be given.
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SuperviSion of the banking Sector
Within the scope of monitoring compliance with large exposure limits, the CSSF intervened 11 times
in writing in 2008 (12 times in 2007), to inform that the maximum level of large exposures had been
exceeded and to request the bank concerned to provide information on the measures it intends to
take to bring back the commitments within the regulatory limits.
2.3. Monitoring of qualitative standards
The CSSF relies on the following instruments to assess the quality of the banks’ organisation:
- analytical reports prepared by external auditors;
- management letters and similar reports prepared by external auditors;
- on-site inspections undertaken by CSSF agents;
- reports prepared by internal auditors of the banks;
- compliance reports.
These reports are analysed according to a methodology laid down in the CSSF’s internal procedures.
The CSSF’s response depends on the seriousness of the problem raised and whether it is repetitive
in nature. It varies from simple monitoring of the problem on the basis of reports, through the
preparation of deficiency letters, to convening the bank’s management or on-site inspections
undertaken by CSSF agents. Where necessary, the CSSF may use its formal powers of injunction and
suspension.
During 2008, the CSSF sent 77 deficiency letters to banks based on shortcomings in terms of
organisation (87 in 2007).
2.4. Analytical reports
The analytical report prepared by the external auditor is one of the most important instruments to
assess the Luxembourg credit institutions’ quality of the organisation and exposure to different risks.
The CSSF requires an analytical report on a yearly basis for every Luxembourg credit institution as
well as for the Luxembourg branches of non-EU credit institutions. Furthermore, credit institutions
supervised on a consolidated basis are required to submit a yearly consolidated analytical report
and individual analytical reports of each subsidiary included in the consolidation and carrying out
an activity of the financial sector.
In 2008, the CSSF analysed 139 individual analytical reports (133 in 2007), 33 consolidated analytical
reports (30 in 2007) and 142 analytical reports of subsidiaries of Luxembourg banks (109 in 2007).
2.5. Co-operation with external auditors
Article 54 of the law on the financial sector governs the relationship between the CSSF and the
external auditors. This article confers upon the CSSF the power to establish the rules relating to the
scope of the audit mandate and the content of the audit report. The professionals supervised shall
communicate all the reports issued by the external auditor within the course of the audit of the
accounting documents to the CSSF.
Furthermore, the external auditors are required by law to inform the CSSF swiftly of any serious
facts, defined more specifically under Article 54(3) of the above-mentioned law, which have come
to their attention in the course of their duties.
The supervision of the CSSF is thus based to a large extent on the work of the external auditors
and their reports. Since 2002, the CSSF holds annual meetings with the main audit firms in order to
exchange opinions on specific issues encountered within the supervised institutions. Discussions also
address the quality of the reports produced and the results of the inspections.
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2.6. On-site inspections
The programme of inspections to be carried out by CSSF agents during the year is set up at the
beginning of the year and is based on the assessment of the risk areas of the various credit institutions.
On-site inspections generally follow standard inspection procedures, in the form of discussions with
the people responsible, assessment of procedures and verification of files and systems.
Since 2004, inspections focus on the internal governance of credit institutions, i.e. the functioning
of the banks’ bodies, the position of the bank within the group, as well as the efficiency of the
control functions such as internal audit. Indeed, the verification of the proper operation of internal
governance and control functions has proved to present the best means used/results ratio for the
CSSF teams.
During the year under review, 66 inspections were carried out, against 52 in 2007. Besides the
inspections of control functions, greater emphasis was laid on the control of compliance with
professional obligations regarding the fight against money laundering and terrorist financing.
Moreover, the missions to validate the internal models within the scope of the implementation of
the Basel II framework continue to absorb a very important part of the resources.
In addition, in 2008, CSSF agents carried out many on-site inspections on the liquidity situation of
Luxembourg credit institutions in close co-operation with the representatives of the Central Bank.
Indeed, in the context of the recent financial crisis, the purpose of these inspections was to take stock
of the liquidity management practices within Luxembourg establishments. The existing practices
will be placed in relation to the principles and recommendations concerning the management and
supervision of the liquidity risk published by BIS and CEBS in 2008.
In addition to the actual on-site inspections, the CSSF also visits the newly established banks on their
premises.
2.7. Combating money laundering
Article 15 of the law of 12 November 2004 concerning the fight against money laundering and
financing of terrorism provides that the CSSF is the relevant authority to ensure compliance with
professional obligations as regards the fight against money laundering and financing of terrorism by
every person subject to its supervision. However, non-compliance with the professional obligations in
full knowledge falls under the penal law and relevant proceedings thus fall within the competence
of the State Prosecutor’s office.
The CSSF uses the following instruments to supervise compliance with these rules: reports of external
auditors and those prepared by internal auditors, as well as the inspections made by CSSF agents.
During the year under review, the CSSF sent 15 letters to banks in relation to shortcomings concerning
money laundering. These letters, based on on-site inspections and/or external or internal audit
reports, listed the shortcomings identified and enquired about the corrective measures envisaged.
Among the most frequently observed shortcomings are:
- an incomplete documentation of customer files, especially during the opening of accounts;
- an incomplete documentation in the context of cash transactions, especially the absence of
information on the origin of the funds;
- the absence of systematic staff training in the fight against money laundering and terrorist
financing;
- deficiencies in classifying the customers according to their risk profile.
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SuperviSion of the banking Sector
The yearly analytical report prepared by external auditors must specifically cover compliance with
legal requirements and the adequate implementation of internal procedures concerning the
prevention of money laundering.
The law of 12 November 2004 requires banks with branches or subsidiaries abroad to ensure that
these entities comply with Luxembourg professional obligations, as far as these subsidiaries or
branches are not subject to equivalent professional obligations provided for by the laws applicable
at the place of their establishment. The CSSF verifies compliance with this requirement by means
of analytical reports of external auditors to be prepared for each subsidiary carrying out an activity
of the financial sector. Furthermore, the CSSF requires that the internal audit of the Luxembourg
parent company periodically verify that subsidiaries and branches abroad comply with the group’s
anti-money laundering directives. The results of these inspections must be included in the summary
report which has to be submitted to the CSSF on an annual basis.
2.8. Management letters
Management letters drawn up by external auditors for the attention of the banks’ management are
an important source of information as regards the quality of the credit institutions’ organisation.
In these reports, the external auditors point out weaknesses they observed in the internal control
system in the course of their assignment. During 2008, the CSSF analysed 63 management letters
and similar documents (68 in 2007).
2.9. Meetings
The CSSF regularly holds meetings with bank executives to discuss business and any problems. It also
requires prompt notification by the banks if a serious problem arises. In 2008, 237 meetings were
held between CSSF representatives and bank executives.
2.10. Specific controls
Article 54(2) of the law of 5 April 1993 on the financial sector, as amended, allows the CSSF to
require an external auditor to conduct a specific audit in a given institution.
The CSSF made use of this power in spring 2008 by inviting three banks of Icelandic origin established
in the financial centre to appoint their external auditor to execute an audit mission regarding their
credit activity and to draw up a report allowing the CSSF to define and evaluate the risks taken
by these banks in relation to this activity. After receiving these reports, the CSSF required certain
recovery measures, all of which could not be implemented before the suspension of payments of
the banks of Icelandic origin.
2.11. Internal audit and compliance reports
The CSSF takes into account the work of the internal audit when assessing the quality of the
organisation and risk management by analysing the summary report which the internal auditor
must prepare every year, as well as the report of the Compliance officer. In 2008, the CSSF analysed
117 summary reports (126 in 2007). It also requested 45 specific internal audit reports in order to
obtain more detailed information on particular subjects (34 in 2007). The CSSF also analysed 113
compliance reports (125 in 2007).
2.12. Supervision of branches of EU banks
The supervision carried out by the CSSF of EU branches established in Luxembourg is limited to
the areas in which the CSSF is responsible as host authority. Thus, Article 45(3) of the law of 5 April
1993 on the financial sector, as amended, appoints the CSSF to supervise the liquidity of these
branches, in co-operation with the competent authority of the home Member State. In order that
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the CSSF exercises its duties in this matter, these branches must provide the same information as the
Luxembourg credit institutions.
In addition, the branches of EU banks must mandate their external auditor to issue the following
reports:
- a report on control of compliance with the legal professional obligations relating to the fight
against money laundering and terrorist financing;
- a report on the compliance with the rules of conduct for the provision of investment services to
clients, in accordance with the provisions of Circular CSSF 07/307 concerning conduct of business
rules in the financial sector.
2.13. Supervision on a consolidated basis
As at 31 December 2008, 31 banks under Luxembourg law (34 at the end of 2007), two financial
holding companies under Luxembourg law (idem in 2007), as well as one financial holding company
incorporated under foreign law (idem in 2007) were supervised by the CSSF on a consolidated
basis.
The conditions governing submission to a consolidated supervision, the scope, content and methods
of supervision on a consolidated basis are laid down in Part III, Chapter 3 of the law of 5 April 1993
on the financial sector, as amended. The practical application of the rules governing supervision on
a consolidated basis is explained in Circular IML 96/125.
As Circular IML 96/125 does not take into account the amendments of the legislation introduced by
the law of 7 November 2007 (the “Basel II law”) transposing Directive 2006/48/EC into national law,
this circular is being recast. The major amendments are in relation to the following points:
- enhanced co-operation between prudential supervisory authorities with respect to consolidated
supervision (Article 50-1 of the law on the financial sector);
- extension of the scope of consolidated supervision which now also includes capital adequacy
for operational risk, the internal capital adequacy assessment process and internal governance
(Article 51 of the law on the financial sector).
The CSSF pays particular attention to the “group head” function set up at the Luxembourg
establishment falling under its consolidated supervision. Thus, the CSSF sees more specifically to the
way the Luxembourg parent company communicates its policies and strategies to its subsidiaries
as well as to the controls set up at the Luxembourg parent company in order to monitor the
organisation and activities of the subsidiaries and their exposures.
The means the CSSF may use for its supervision on a consolidated basis are manifold:
- The CSSF requires periodic reports reflecting the financial situation and the consolidated risks of
a group subject to its consolidated supervision.
- The ICAAP report shall provide an assessment of the consolidated capital adequacy in relation
to the risks taken by the group or sub-group. Part of this report concentrates to explain the
consolidated risk profile of the group or sub-group subject to the consolidated supervision.
- The reports prepared by the external auditors are another source of information. Circular CSSF
01/27 on practical rules regarding the mission of the external auditor requires that a consolidated
analytical report of a group subject to the consolidated supervision of the CSSF must be drawn
up. The purpose of this consolidated report is to provide the CSSF with an overview of the group’s
situation and to inform on the risk management and structures of the group.
- The CSSF requires an individual analytical report for each major subsidiary.
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SuperviSion of the banking Sector
- By virtue of Circular IML 98/143 on internal control, a summary report on the activities carried out
by the internal audit department is to be communicated to the CSSF on an annual basis. The CSSF
requires that the scope of intervention of the internal audit of the Luxembourg parent company
be extended also to the subsidiaries in Luxembourg and abroad. This report must mention the
controls carried out within the subsidiaries and the results thereof. The main observations made
within the subsidiaries as regards the compliance function defined in Circular CSSF 04/155 shall
also be mentioned therein.
- The CSSF’s information is supplemented by contacts, exchange of letters and meetings with
supervisory authorities of the subsidiaries’ host countries. Within the scope of its supervision
on a consolidated basis, the CSSF expects to systematically obtain, from the banks and financial
holding companies subject to consolidated supervision, information on any intervention of the
host country authorities with the subsidiaries, where these interventions concern non-compliance
with domestic regulations and aspects regarding organisation or risks of these subsidiaries.
- As regards groups with an important network of subsidiaries, the CSSF follows the development
of the financial situation and the risks of the subsidiaries included in the consolidated supervision
by means of regular meetings with the management of the Luxembourg credit institution or the
financial holding company under consolidated supervision.
- The CSSF performs on-site inspections that cover, on the one hand, the manner in which the
parent company sets up its policies and implements its strategies within the subsidiaries and, on
the other hand, the follow-up applied to the subsidiaries. Until now, the CSSF has not carried out
itself any on-site inspection at the premises of foreign subsidiaries of Luxembourg banks.
The CSSF also investigates indirect participations of banks subject to its consolidated supervision in
accordance with the terms of Circular IML 96/125.
The law of 5 November 2006 on the supervision of financial conglomerates and amending the law
of 5 April 1993 on the financial sector, as amended, requires the CSSF to verify that Luxembourg
credit institutions whose parent undertaking is a credit institution or a financial holding company
having its head office in a third country, are subject to a consolidated supervision by the competent
authority of that third country that is equivalent to the consolidated supervision performed by the
CSSF on credit institutions and financial holding companies. If there is no equivalent consolidated
supervision by the third country, the CSSF must perform a consolidated supervision of this group or
apply another method in order to achieve the objectives of consolidated supervision.
2.14. Supplementary supervision of financial conglomerates
The law of 5 November 2006 on the supervision of financial conglomerates introduces a
supplementary supervision on financial conglomerates into Luxembourg law. A financial
conglomerate is a group that includes at least one important regulated entity within the banking
or investment services sector and one important entity within the insurance sector.
The law requires the CSSF to perform a supplementary supervision of the financial conglomerates
for which it exercises the role of coordinator of the supervision, the coordinator being the authority
responsible for the coordination and supplementary supervision of the financial conglomerate.
The CSSF’s supplementary supervision of financial conglomerates does not affect at all the sectoral
prudential supervision, both on the individual and consolidated level, by the relevant competent
authorities.
The practical consequences of this law for Luxembourg credit institutions and investment firms are
limited as things stand at present. Indeed, the CSSF has not identified any financial conglomerate
for which it should exercise the role of coordinator of this supplementary supervision at this stage.
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2.15. International co-operation in matters of banking supervision
International co-operation, which has already been very comprehensive in the past, was further
strengthened by Directive 2006/48/EC relating to the taking up and pursuit of the business of credit
institutions. There are three types of co-operation:
- the traditional bilateral co-operation as performed since the beginning of the 1980s;
- the strengthened multilateral co-operation with respect to certain groups; and
- the co-operation as set out in Article 129 of the above-mentioned Directive.
2.15.1. Traditional bilateral co-operation
Following the implementation of the second banking Directive, the CSSF concluded memoranda of
understanding with the banking supervisory authorities of several Member States of the European
Economic Area in the 1990s, with a view to specifying the terms of co-operation. These memoranda
concern in particular the supervision of credit institutions involved in cross-border operations by
way of the freedom to provide services or through the creation of branches.
Moreover, in accordance with the legal provisions in force, the CSSF co-operates and exchanges
information on an informal basis with a number of other counterpart authorities.
In 2008, the CSSF held three bilateral meetings with banking supervisory authorities6 in order to
exchange prudential information on supervised institutions having a presence in both countries.
Besides the consultations required under the European Directives, the CSSF also informs the relevant
authorities of all significant facts relating to supervision. In particular, it consults the relevant
authorities regarding acquisitions of major holdings and restructurings of share ownerships.
2.15.2. Strengthened multilateral co-operation with respect to certain groups
The decentralised organisation of operational management units and centres of competence of
certain banking groups called for an adaptation of the co-operation and prudential supervisory
modes of the activities of these groups. In this context, the CSSF has signed specific co-operation
agreements with:
- the Belgian and French authorities for the supervision of the DEXIA group;
- the German authority for the supervision of the Clearstream group;
- the Canadian and Belgian authorities for the supervision of the RBC Dexia group.
The key objective of such specific co-operation agreements is to ensure that all banking activities
of these groups are adequately supervised. To this end, the authorities ensure in particular that the
various sets of regulations are applied in a consistent manner in order to avoid any unbalanced
treatment within the groups.
Co-operation between authorities is enacted on several levels:
- close consultation between the authorities in order to coordinate and align their prudential
supervision;
- continuous and systematic exchange of information on any significant event likely to impact the
group or its main constituent entities;
- regular consultation for the principal purpose of updating the list of points requiring the
attention of the authorities within these groups, co-ordinating the drafting of control plans and,
finally, examining the appropriateness of on-site inspections to be carried out by the competent
authority in close co-operation with the other relevant authorities.
6 Bundesanstalt für Finanzdienstleistungsaufsicht (Germany), Commission bancaire, financière et des assurances (Belgium),
Autorité fédérale de la surveillance des marchés financiers (Switzerland).
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SuperviSion of the banking Sector
Besides frequent exchanges of information between the persons directly responsible for the
supervised entities and each authority concerned, the CSSF attended 15 meetings within the
framework of this specific co-operation.
2.15.3. Co-operation in accordance with Article 129 of Directive 2006/48/EC
Co-operation between European competent authorities assumes a new dimension under Article
129 of Directive 2006/48/EC which requires intensive co-operation between the relevant competent
authorities of cross-border banking groups and strives towards a more centralised supervision of
these large cross-border groups at EU level.
Thus, the competent authority for the consolidated supervision of a European banking group shall
henceforth plan and coordinate the prudential activities in co-operation with the other relevant
competent authorities. In 2008, the CSSF participated in 14 meetings concerning each a large
banking group and which were held within the context of strengthening the co-operation between
European authorities for the purpose of consolidated supervision.
Similarly, for cross-border banking groups seeking to use advanced approaches for the calculation
of capital requirements for credit risk or operational risk, European regulations require that the
competent authorities co-operate closely to decide on authorising the use of these advanced
approaches by the banking group. In the absence of a joint decision, the authority competent for the
consolidated supervision of the banking group makes its own decision, which must be recognised
by the other competent authorities as final and be applied by these authorities. In this context, the
CSSF verifies the local use by the Luxembourg entity of the new risk management models and capital
measurement models implemented by various banking groups and communicates its conclusions to
the competent authorities in charge of the consolidated supervision.
2.16. Special points and decisions
2.16.1. Practical aspects relating to prudential filters
Since the prudential financial reporting (FINREP) is based on international financial reporting
standards (IFRS), some prudential filters must be applied to accounting capital in order to establish
the banks’ regulatory capital used to calculate the capital ratio.
The prudential filters of portfolio revaluation reserves available for sale have been subject to
discussions and decisions by the CSSF in 2008.
Thus, Circular CSSF 06/273 defining the capital ratios initially provided that unrealised losses and
gains on debt securities categorised as available-for-sale assets (AFS) should be deducted in full from
original own funds or may be included in additional own funds. Considering CEBS’ (Committee of
European Banking Supervisors) options for the assessment of unrealised results on available-for-sale
debt securities, namely either to take into account these unrealised results during the calculation
of regulatory capital, or to take no account of it, the CSSF decided to let the credit institutions
choose between those two methods. Those can therefore, with the CSSF’s approval, also opt for
the method consisting in disregarding the revaluation results on this securities category for the
calculation of prudential own funds. The chosen option shall be permanently applied. Circular CSSF
06/273 will be adapted accordingly in the next update.
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2.16.2. Supervisory Review Process
a) Regulatory basis
Directive 2006/48/EC of 14 June 2006 is the European counterpart of Basel II, published in June 2004
by the Basel Committee on Banking Supervision. The Supervisory Review Process is the second Pillar
of the regulatory framework, besides the Minimum Capital Requirements (Pillar I) and the Market
Discipline (Pillar III). In Luxembourg, Directive 2006/48/EC has been transposed in national law by
the law of 7 November 2007 and by Circular CSSF 06/273 of 22 December 2006.
Pillar II has been covered by two additional circulars specifying some provisions:
- Circular CSSF 07/301 on the implementation of the Internal Capital Adequacy Assessment Process
(ICAAP);
- Circular CSSF 08/338 on the implementation of a stress test in order to assess the interest rate risk
arising from non-trading book activities.
Finally, CEBS published detailed guidelines on the Supervisory Review Process (document CP03 of
25 January 2006).
Pillar II is defined as the supervision by the supervisory authority of the provisions, strategies,
procedures and mechanisms implemented by the banks in order to comply with the banking
regulation, and as the measurement by the supervisory authority of the risks the banks are or could
be exposed to.
b) Practical implementation
The monitoring system in force already covered most of the Pillar II requirements, so that a material
change was not necessary. This system had, however, to be structured differently and completed on
certain points.
Pillar II comprises the following elements:
- Internal Capital Adequacy Assessment Process (ICAAP);
- Internal Governance;
- Supervisory Review and Evaluation Process (SREP);
- structured dialogue;
- prudential measures.
• Internal Capital Adequacy Assessment Process (ICAAP)
The ICAAP requirements are detailed in Part XVII of Circular CSSF 06/273 and in Circular CSSF 07/301.
ICAAP is an internal process allowing the banks to evaluate whether their capital is sufficient to
cover all the risks to which they are or could be exposed. Due to its internal nature, no particular
framework of this process was prescribed. ICAAP must be subject to a written annual report to be
submitted to the administrative or supervisory bodies and to the CSSF. This report shall cover the
following aspects:
- the risk profile;
- ICAAP’s adequacy in relation to the bank’s organisation and needs;
- the results of stress tests. The institutions shall identify the stress scenarios likely to affect their
capital and simulate the effects of these scenarios. The banks using the internal models to calculate
capital requirements must, moreover, carry out certain stress tests prescribed by Pillar I.
- Internal capital adequacy in relation to the risks.
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• Internal Governance
Directive 2006/48/EC lists a certain number of principles on good internal governance, the review of
which is subject to a supervisory review process. CEBS’ CP03 specified these principles in 21 points
of internal governance (IG). The CSSF supervises these points partly on basis of the report of the
external auditor and partly on basis of a supervisory plan of internal governance used by the CSSF
agents during their inspections.
Most of the 21 points recommended by CEBS were already covered by existing assessment
instruments. Until now, the following points were not yet imposed expressis verbis by the
Luxembourg regulation:
- IG 4: The responsibilities of the bodies as well as the business objectives, risk strategies and risk
profile should be defined in a document.
- IG 12: The management body should have policies for selecting, compensating, monitoring and
planning the succession of key executives. The compensation policy shall not encourage rash risk
taking.
- IG 19: The management body should put in place internal alert procedures (whistle blowing) for
communicating internal governance concerns from the staff.
• Supervisory Review and Evaluation Process (SREP)
Directive 2006/48/EC requires an annual prudential review of the credit institutions. Inspired by the
document CP03 of CEBS, the CSSF developed an assessment methodology which takes into account
a certain number of quantitative and qualitative criteria and which results in a scoring of banks.
The methodology differentiates essentially between the elements inherent in the “general
situation” and the “risk profile” of the institution.
The following elements are taken into account for the assessment of the general situation of an
institution:
- the quality of the shareholders, the potential capacity and will of the shareholders to support and
the presence of a consolidated supervision;
- the quality of internal governance;
- the quality of the internal organisation; a particular emphasis is laid on recurrent shortcomings
mentioned in the management letters and recorded during the inspections;
- the quality of the control functions (internal audit, compliance and risk management);
- the analysis of certain financial ratios which are used to assess the quality of the own funds
(proportion of original own funds compared to borrowed capital), the gross leverage (assets and
gross off-balance sheet elements compared to own funds) and the profitability.
All these elements allow setting a first scoring.
The following elements are used to set the risk profile:
- the determination of the activities exercised;
- the assessment of credit risk which takes into account the exposures in all form, of stress tests, of
residual risks during the use of the risk mitigation techniques, of the securitisation risks and of the
exposures on the markets which are not well-known or mastered;
- the interest rate risk, and more particularly the results of the stress tests covered by Circular CSSF
08/338 which simulates the effect of a 2% interest variation in the market on a bank’s economic
value;
- the other risks (liquidity, exchange, market, etc.).
All these elements allow setting a second scoring.
45
chapter i
• Structured dialogue
If the CSSF deems it necessary, it will enter into a structured dialogue during which both the results
of SREP and the conclusions of ICAAP will be discussed. The scoring results will also be communicated
to the banks, but cannot be made available to the public.
• Prudential measures
In accordance with Article 53(2) of the law of 5 April 1993 on the financial sector, as amended, the
CSSF may, in particular, require a surplus in own funds compared to the regulatory minimum if it
assesses that the own funds detained do not ensure an adequate management and hedge of an
institution’s risks. Such a measure will be imposed individually and will be duly reasoned. It may
particularly intervene in case of risk concentration in a specific area.
2.16.3. Essential rules of internal control regarding private banking
It is useful to remind, from time to time, of some essential rules of internal control regarding private
banking. The private banking activity implies indeed non-negligible risks. The materialisation of
these risks may even present a danger for the survival of a bank. The CSSF regularly acknowledges
events which result in significant losses. The observation of some basic rules may substantially
reduce these risks.
• A clear distinction should exist between the services of discretionary management, advice
management and simple execution.
If the practice of a business relationship with a client differs from the contractual basis, the bank
will be in a difficult legal position in case of litigation. For example, a client opted for advisory
management. As time went, the account manager has taken the habit to take decisions instead
of the client, with the implicit approval of the latter. In case of litigation, the bank will not have
evidence that the client ordered the past transactions on his account and the bank may be liable to
compensate the client for the loss.
The service provided must, thus, always correspond to the one laid down in the agreement with
the client.
• The set risk profile must be observed.
If the bank offers several choices of risk profile regarding discretionary and advisory management,
it must, of course, scrupulously observe them. Thus, a client who opted for a conservative risk profile
cannot have a portfolio only constituted of shares. The bank must have a supervisory system to
ensure the correlation between the profiles and the real management.
• The information to the client shall not be compromised.
The bank shall be able to prove that the portfolio situation as it is presented in the books is regularly
reported to the client who implicitly approves it if there is no complaint within a certain time
limit.
This proof is sometimes difficult to produce for the clients having hold-mail. The procedure
commonly applied to ensure regular information to the client consists in the transmission of the
mail during the client’s visit by a person independent of the manager. Clients with hold-mail who
have not received their mail for a certain time must be subject to a close follow-up. The banks must
also ensure that parallel communication channels (by fax, by e-mail, etc.) were not installed.
46
SuperviSion of the banking Sector
• The transmission of cash and physical securities must be supervised by a second person.
The cashier must be physically present during each withdrawal or paying-in. Similarly, each delivery
and withdrawal of physical securities must be executed in the presence of a second employee of
the bank.
• The clients’ complaints must be taken seriously and dealt with by a neutral body.
Internal frauds or organisational malfunctioning may sometimes be the source for clients’ complaints.
This is the reason why these complaints must be taken seriously and a neutral body within the
bank must critically investigate, i.e. not to be satisfied with superficial explanations from account
managers.
• The input of the clients’ identification data must be supervised.
Changes in the clients’ identification data (name, mailing address, etc.) must be made according to
the principle of the separation of tasks.
• Rules regarding holidays.
Each employee of the bank should take at least two consecutive weeks of holidays per year. During
the holidays, it should be ensured that the replacement will indeed take on responsibility for the
absent manager’s clients. The manager shall, in principle, not access his working place during his
holidays.
2.16.4. Segregation requirement between the clients’ financial instruments and the bank’s
financial instruments with the sub-depositaries
The law of 13 July 2007 on markets in financial instruments (MiFID law) and Grand-ducal regulation
of 13 July 2007 relating to organisational requirements and rules of conduct in the financial sector
presented specifications for the protection of clients’ financial instruments deposited in Luxembourg
credit institutions and investment firms as well as in Luxembourg branches of credit institutions and
investment firms having their registered office in a third country and sub-deposited with third
parties.
Article 18(1) d) of the above-mentioned regulation requires the professionals concerned to take
any necessary measures to ensure that all clients’ financial instruments deposited with a third party
may be identified separately from the financial instruments belonging to these credit institutions
or investment firms.
In order to make the credit institutions aware of this requirement, the CSSF asked, in 2008, all
Luxembourg credit institutions and branches of credit institutions having their registered office in
a third country about the compliance with the segregation requirements between their financial
instruments and those held on behalf of their clients with all their sub-depositaries. Moreover,
they were invited to confirm that all the sub-depositaries were clearly informed which financial
instruments belong to the professionals and which to their clients.
Furthermore, Article 37-1(7) of the law of 5 April 1993 on the financial sector, as amended, requires
the depositaries of clients’ financial instruments to take adequate measures to preserve the property
rights of their clients, particularly in case of insolvency of the credit institution or investment firm.
It results from this requirement that they have to deposit their clients’ financial instruments with
sub-depositaries which would have no hold on the clients’ financial instruments sub-deposited
with them, in case of insolvency of the credit institution or investment firm, whether pursuant to
contractual or legal provisions.
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